The Los Angeles Clippers NBA franchise is being sold to Steve Ballmer, the former Microsoft
MSFT, -0.38%
chief executive, for a cool $2 billion, according to media reports late Friday indicating that a binding agreement had been signed. That would be the highest price ever paid for an NBA team — by far. Donald Sterling, the disgraced current owner, bought the Clippers for a mere $12.5 million back in 1981.

The Ballmer bid

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Former Microsoft chief Steve Ballmer has reached an agreement to buy the Los Angeles Clippers for $2 billion, but that may not be the end of the road for disgraced owner Donald Sterling.

Now, enquiring minds want to know about the tax hit that Sterling will face. Based on available information, it will probably be about $662 million. Here is my best guess at the full tax story.

Deal structure

The Clippers organization is apparently organized as a corporation. According to media reports, the legal owner of the team is the Sterling Family Trust (SFT), which is presumably a garden-variety “living trust” set up mainly to avoid probate (the time-consuming and expensive process of obtaining court approval to distribute the assets of a deceased person’s estate). Such living trusts are common in California, and they are completely ignored for income tax purposes. If the Ballmer acquisition is structured as a purchase of SFT’s stock (the most likely scenario), there will be no corporate-level taxes owed when the Clippers are sold. Because California is a community property state, Sterling and his wife Rochelle (known as Shelly) are considered by state law to effectively be 50/50 co-owners of the team (via SFT and the corporation). Assuming I’ve got the deal structure right, the Sterlings will personally owe all the federal and state income taxes that will result from selling the team for a whopping long-term capital gain of about $1,987,500,000 (sale price of $2 billion minus original cost of $12.5 million).

Thanks to legislation enacted early last year, the maximum federal income-tax rate on long-term capital gains is now 20% (up from 15% before 2013). So the federal capital-gains tax hit on the Clippers sale will amount to about $397,500,000 (20% times the $1,987,500,000 gain).

What about the 3.8% Medicare surtax on net investment income, you ask? Good question. The 3.8% tax does not apply to gains from selling “nonpassive” business assets. If the Sterlings have each spent over 500 hours per year on team-related management activities, the team would qualify as a nonpassive asset, and the 3.8% tax would not apply to either spouse, even if they file separate returns. If they file jointly, the over-500-hours test would be passed if their combined hours spent on management-related activities exceeds the 500-hour threshold. So, one way or another, I expect the Sterlings will successfully escape the clutches of the 3.8% tax.

State income tax

Unfortunately for the Sterlings, California is now one of the worst places for rich folks to live, taxwise. That’s because the current maximum state income-tax rate on capital gains is 13.3% (up from 10.3% before 2012). The Sterlings will surely owe the maximum 13.3% rate, so the state income-tax hit from selling the Clippers will be about $264,337,500 (13.3% times $1,987,500,000).

The bottom line

With a 20% federal income-tax rate and a 13.3% state income-tax rate, the Sterlings will owe almost one-third of their profit from selling the Clippers to the tax collectors. That would amount to about $662 million. Yikes!

As stated earlier, the good news is they will probably not owe the 3.8% Medicare surtax.

However, this is not the end of the tax story for the Sterlings. Sooner or later, the federal estate-tax will fall due at a rate of 40%. For instance, if they both die this year (from their shockingly high income-tax bills or otherwise), their two federal estate-tax exemptions would shelter a relatively negligible $10.68 million. So the feds would be owed about another $531 million for estate tax — at 40% times the $2 billion sale price minus $662 million for income taxes minus $10.68 million for two estate-tax exemptions.

And so, with $662 million in income taxes plus $531 million in estate tax on a $2 billion sale, one would have a hard time making the case that the rich aren’t paying enough in taxes.

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